As cryptocurrencies gather momentum among investors, it is no surprise that both the public and the ATO are turning their thoughts towards those who invest in this digital asset.

It should also come as no surprise that tax is an afterthought for many seeking to jump on board, particularly given the sharp rise in popularity and value of cryptocurrencies.

Currently, there are over 1,200 different cryptocurrencies, with Bitcoin having the largest market capitalisation — in excess of USD$100b. While the task of addressing the tax treatment of each cryptocurrency is beyond the scope of this article, set out below is a summary of the tax treatment of Bitcoin and other crypto or digital currencies that have similar characteristics.

The important messages to take away are:

given the recent sustained upward movement in value of Bitcoin, don’t assume that the profit on Bitcoin transactions is not taxable or not subject to CGT. Even if gains from Bitcoin transactions are not reported, the ATO may issue amended or default assessments if they believe a taxpayer is living beyond their means

those who invested in very recent times where the value of Bitcoin has fallen may make losses that are deductible if there was a profit-making intention on acquisition, and

clear records of transactions, activities and the intentions behind them must be kept, particularly if Bitcoin is purchased both for personal use and for speculative gain.

What is Bitcoin?

Bitcoin is one of many cryptocurrencies, with alternatives to Bitcoin often being referred to as Altcoins. On the Bitcoin blockchain, transactions take place between users directly (peer-to-peer) and are verified by a network. Transactions on the blockchain only become permanent once they are verified by the network.

The network is represented by a community of nodes (ie host computers) which run Bitcoin software. Through the use of computer-processing power, each member of the network is repeatedly updating and verifying transactions on its copy of the ledger, which helps to keep the blockchain consistent, complete and unalterable.

The verification service carried out by members of the network is called “mining”, and the reward for this service comes in the form of new Bitcoin and a share in transaction costs. Other blockchain-based cryptocurrencies may have different bases of providing rewards.

The Bitcoin blockchain maintains a record of ownership without the need for a central authority or government backing.

Are gains made on Bitcoin taxable?

In its online guidance, the ATO has stated its view that Bitcoin (and other crypto or digital currencies that have similar characteristics) are capital gains tax (CGT) assets.

Investment & personal transactions

Where a person or entity has purchased Bitcoin for investment and is not carrying on a business of Bitcoin investment, any profit from resale will generally be assessable as a capital gain and not on revenue account.

The threshold question is whether someone buying Bitcoin can evidence that it was purchased for investment purposes when there is no expectation of a periodic return, such as rent from an investment property or dividends from listed shares. In many cases, the ATO will consider that the buyer did so for a profit-making purpose and not for investment.

If Bitcoin has been held as an investment by certain individuals and trusts for more than 12 months, a 50% CGT discount may apply to reduce the taxable gain.

As Altcoins are commonly purchased using Bitcoin, and not cash, it may be difficult to access the 50% CGT discount unless the original Bitcoin has been held for 12 months. In any event, subject to market movement there may be little gain or loss where Bitcoin is purchased and disposed of in a short period of time to purchase Altcoin.

The ATO is clear in its view that Bitcoin is neither money nor a foreign currency. However, in such circumstances, the CGT rules or the profit-making scheme rules may operate similarly to the foreign currency tax rules in calculating the gain or loss on conversion from Bitcoin to Altcoin.

If the intention in purchasing Bitcoin is to use it to buy goods or services for personal consumption (ie retail goods, home utility services or food and beverages), then any profit from resale will be assessable as a capital gain and the 50% discount may apply. Where the original cost of purchase was under $10,000, any gain made will be tax free as it is a “personal use asset”. Following is an example of how this could work.

Example

Sarah bought $4,000 of Bitcoin on 1 January 2013 with the intention that, once it became more widely accepted, it would be used to buy goods or services for personal consumption.

Sarah has not yet disposed of her original Bitcoin, as popular uptake has been slow, and her original Bitcoin are now worth $20,000.

Over the course of 2017, Sarah spends her Bitcoin on coffee, food, drink and a gym membership.

Sarah will pay no tax on the gain that she made of $16,000.

It is important to remember that, each time Bitcoin is used to purchase goods or services for personal consumption, or Altcoin, it will be considered as a disposal for tax purposes.

Traders and speculators

For traders, speculators and those who buy Bitcoin with a profit-making purpose, any profit from resale will be assessable income (ie revenue income and not treated on capital account) unless such activity can be classified as a hobby. Expenses incurred in purchasing Bitcoin will be fully deductible for traders/speculators.

A profit-making purpose is likely to prevail in the majority of circumstances, as ownership of Bitcoin does not (at this point in time) entitle the holder to rent or a periodic return as may be the case with assets such as property or shares. Even if Bitcoin is held for a significant period of time, it may still be considered to have been purchased for a profit-making purpose, particularly in light of the absence of a periodic return.

However, as more businesses in Australia and around the world begin to accept Bitcoin as payment, there is an increasing case for the argument that Bitcoin was purchased for a purpose other than speculation or profit making.

Bitcoin in business

Where Bitcoin is received in return for goods or services provided through a business, its Australian dollar value will need to be included in the ordinary income of the business. Similarly, if carrying on a business there will be an entitlement to a deduction for goods or services purchased using Bitcoin. The easiest way to determine the Australian dollar value of Bitcoin is through a reputable Bitcoin exchange.

The law on the GST treatment of digital currencies has undergone changes, which result in some digital currencies being treated like “money”.

Bitcoin exchanges

Where a taxpayer is carrying on a business of buying and selling Bitcoin as an exchange service, the Bitcoin held will be considered trading stock. All proceeds will be included in assessable income, and the taxpayer will be required to bring to account any Bitcoin on hand at the end of each income year. Any expenses incurred, including in the purchase of Bitcoin, will be deductible.

Mining

Although the ATO has not released any specific guidance, it is likely that if a taxpayer is mining Bitcoin they will be considered to be carrying on a business of Bitcoin mining. As such, the Australian dollar value of Bitcoin rewards from mining, and any gains made from the sale of mined Bitcoin, will be included in assessable income. Expenses incurred in mining activities should be deductible.

Tax reporting and record-keeping obligations

Taxpayers have an obligation to report their assessable income each income year and to keep appropriate records to support their income tax return disclosures.

Given the decentralised and unobservable nature of cryptocurrency, it is likely that the ATO and other government agencies will not be able to track all transactions and trades — at least for the time being. However, if a taxpayer is living beyond their means, and reported income, they may nevertheless face an ATO review or audit. A decline in bank account activity could also be a trigger for ATO review or audit.

If the ATO conducts a review or audit and has reason to believe that a taxpayer has not reported all of their assessable income, it may issue them with an amended income tax assessment. If the taxpayer refuses to cooperate with the ATO, they may issue them with a default income tax assessment where they will estimate the taxpayer’s actual assessable income based on what they consider to be reasonable grounds.

Those investors/speculators who make a loss need to consider whether that loss is deductible (only if a profit-making purpose existed) or a capital loss on investment is available (only where acquisition costs are more than $10,000).

If a taxpayer has been issued with an amended or default assessment, they will have the onus of objecting to the assessment and proving that it is excessive.

Regardless of individual circumstances, if a taxpayer is transacting in Bitcoin they should keep a record of all of their trades and activity. In this regard, many exchanges will allow users to access and download their transaction history.

Finally, if a taxpayer is purchasing Bitcoins for both personal use and speculation, it is particularly important that they keep clear records. This is because it will be up to the taxpayer to show the intention behind each purchase and transaction.

This article was published in CCH Tax Week. CCH iKnow has useful information on tax and superannuation.